Board Minutes point to 50 basis point increase in August
The RBA Board has lifted the intensity of its rhetoric in the July Minutes. The option of a 25 basis point increase is quickly dismissed, economic prospects are upbeat, while the need to contain inflationary expectations is paramount, another 50 basis points in August seems highly likely.
The contrast between the July RBA Board Minutes and the June Minutes is remarkable.
In June, the Board discussed the options of 25 basis points and 50 basis points giving both cases a “fair hearing”.
The argument in favour of 25 basis points in June was “a steady approach to withdrawing monetary policy stimulus and that was appropriate in an uncertain environment… while some central banks had been increasing policy rates in 50 basis point increments, these central banks meet less frequently than the Reserve Bank Board…. on balance members agreed to a 50 basis point adjustment.”
For the July meeting there was no reference to “on balance”, or the frequency of RBA Board meetings or even any support for a 25 basis point move.
The only reference to 25 basis points was “members considered the possibility of raising interest rates by 25 basis points or 50 basis points. Members agreed that arguments for raising interest rates by 50 basis points were stronger”, the justification was exactly the same as in June despite rates being 50 basis points higher, “the level of interest rates was still very low for an economy with a tight labour market and facing a period of higher inflation.”
Further, “members agreed that further steps would need to be taken to normalise monetary conditions in Australia over months ahead.”
The July Minutes certainly support our view that another 50 basis point increase can be expected at the August 2 Board meeting.
There is also muted evidence that the Board is becoming concerned about the impact of policy on the economy. “Members agreed that the outlook for domestic economic activity had eased a little, with a key source of uncertainty relating to the response of households to rising inflation, higher interest rates, and declining housing prices in some cities.”
But this observation did not raise any concerns in the key section on Considerations for Monetary Policy, - “recent spending data had been positive, … household saving rate is also still higher than it was before the pandemic…households have built up large financial buffers…. Housing prices remained significantly higher than prior to the pandemic.”
And, of course, we have the labour market, “continued strong employment growth… consistent with reported hiring intentions of employers in the Bank’s liaison program… other information in June affirmed the outlook for faster wages growth … around 60% of private sector firms in the Bank’s liaison program had reported they expected wages growth to pick up over the coming year.”
Note that the July Board meeting was held before the recent Employment Report which revealed that the unemployment rate had fallen from 3.9% in May to a fresh 48 year low of 3.5% in June.
Other observations about the current state of the economy: “timely data indicated growth in domestic demand had remained solid in the June quarter”, “business surveys and information from the Bank’s liaison program suggested the investment intentions of non mining firms remained at or above average levels.”
It has become apparent that globally, central banks are committed to containing inflationary expectations ahead of fine tuning the impact on the economy of a tightening in financial conditions. The RBA appears to fall into that group. In the key final paragraphs of the Considerations section the Board emphasises, “Members viewed it as important that inflation expectations remained well anchored and that the period of higher inflation be temporary.”
As to the evidence to date on inflation expectations, the Minutes state that, “Members noted that, while short-term inflation expectations had risen with actual inflation, longer-term measures of inflation expectations were well anchored”.
The Concept of the Neutral Rate
In a welcome surprise the Board discussed “the staff’s estimates of the neutral real interest rate for Australia.”
The Board notes, “the staff apply a range of methods for estimating the neutral rate each with its own advantages and disadvantages, and each method produces a different estimate. The range of estimates is wide.”
The Board observed that “the current level of the cash rate is well below the lower range of estimates for the nominal neutral rate; if inflation expectations rise…. the level of nominal rates will be higher than otherwise; neutral rate framework provides only a general guide and specific estimates need to be treated with caution.”
The Minutes do not specify the estimated range of neutral.
Conclusion
When central banks make a big decision, the commentary will usually err on the side of justifying the decision.
But there is more than that in these Minutes. The standard practice of 25 basis point increments appears to have been discarded for the time being.
The assessment of the economy is quite upbeat highlighting the obvious strength of the labour market; risks around the outlook for wages growth; and the current resilience of spending. The collapse in consumer confidence is noted but qualified against the current spending. The weakness in the housing market is compared with how far prices have already increased.
Further rate hikes are clearly being signalled while the “neutral rate” is seen to be well above current rates.
The inflation outlook is deteriorating further – electricity; gas prices; rents; materials; and the liaison pointing to business’ greater pricing power.
While the Minutes do refer to the upcoming Inflation Report a downside surprise is unlikely to have any real influence on the decision in August.
Nevertheless, we do expect that the Board will resist the option to raise the cash rate by 75 basis points in August with 50 basis points remaining the preferred option.
After all, there are still four more meetings this year.
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